Vendor Management

In university, I wrote a paper on the role of attractiveness in selecting one’s spouse. I was interested in this issue because, whilst the evidence strongly supported the proposition that spouses tended to be similarly attractive, the prevailing causal theory didn’t sit well with me. The prevailing theory explained the evidence as follows:

1. everyone tries to get the hottest guy or girl they can,
2. the distribution of attractiveness of men and women follows the same curve, thus
3. the hottest couples pair off and the less hot couples settle for each other.

The reason this didn’t sit well with me, aside from dooming me to never be with hot chicks, was that, whilst couples on average tended to be similarly attractive, the evidence showed substantial variance in attractiveness. If everyone was pairing off as the theory suggested, the variance should be minimal or at least consistent across the population.

After gathering as much of the data from previous studies as I could get my hands on, I found that a different model also explained the observation that couples tend to be similarly attractive. My model was that each person has a base attractiveness requirement that, once met, permitted selection on other characteristics such as sense of humour, confidence, or skill at dancing the Macarena. This explained both the average result as well as the variance and, with dancing practice, meant that I too could one day score hot chicks.

Successful long-term supplier relationships seem to follow a similar pattern. Once the buyer and supplier are satisfied that they are receiving a demonstrably attractive price, they can then focus on other aspects of the relationship such as innovating to create additional value for their companies, investing to integrate their AP/AR systems to transact more quickly and easily etc. Conversely, selecting the supplier with the most attractive price may require forgoing other characteristics that may be more valuable to you than exceeding your base price requirements.

The games played by game theorist don’t exist in the real world. The assumption is that each player is motivated solely by their stated payoffs whereas in real life we are motivated to do more than maximise our material rewards. Sometimes we are motivated to maximise other’s rewards or the total rewards available to all players. Occasionally, we are motivated to minimise other’s rewards even at the expense of our own. But despite the inevitable simplification required by game theory, the very act of simplifying can uncover some useful features of the games we play.

Long term supplier relationships is the game I’m most interested in.

One of the simplest games (and therefore one of the most studied) is where two players choose to cooperate with each other or defect. Their respective payoffs depend on the choice made by the other player. Table A below is the standard way of representing the payoffs received by each player. The left-hand number in each cell is Player A’s payoff whilst the right-hand number is Player B’s payoff. For example the bottom centre cell (30,1) in the “Player A: Defect” row and “Player B: Cooperate” column shows that when Player A defects and Player B cooperates Player A gets $30 whilst Player B only gets $1. The efficiency of the player’s decisions is the sum of their payoffs relative the maximum sum of payoffs. In the above example the sum of the payoffs is $31 compared to a maximum payoff of $40 (calculated by adding the 20,20 values in the centre cell in the table).

The Prisoner’s Dilemma is a specific type of this game where the players when acting in their individual best interest create inefficient outcomes. The emotive example is a patrons exiting a theatre on fire. The surest method of saving the most patrons is for everyone to exit in an orderly manner. The surest method of saving yourself whilst everyone else is proceeding orderly is to rush the exit and get out first. Everyone rushes the exit. Many die. An inefficient outcome.

The following table demonstrates how this can occur. The “20, 20″ cell shows that, if Player A cooperates with Player B, they will each receive $20. The “1,30″ cell to the right shows that, if Player A cooperates and Player B defects, then Player A will receive $1 and Player B will receive $30. Likewise for the next row, the “30, 1″ cell shows that, if Player A defects and Player B cooperates, Player A will receive $30 and Player B will receive $1. The final cell shows that if both players defect then each will receive $5.

Table A: Standard prisoner’s dilemma

Faced with these payoffs, what should Player A do? To answer this question, one need only look at the left-hand number in each cell. The “Player B: Cooperate” column shows that Player A will get $20 if he cooperates and $30 if he defects therefore, if Player B cooperates, Player A’s best choice is to defect. The “Player B: Defect” column shows that Player A will get $1 if he cooperates and $5 if he defects. Again, his best course of action is to defect. In game theory lingo, defecting is Player A’s dominant strategy. Note that defecting is also Player B’s dominant strategy. In game theory lingo, this is known as a Nash Equilibrium.

But if both Player A and Player B defect, they only receive $5 each - a total payoff of $10. Had they cooperated, they would have received $20 each for a total payoff of $40. This is the Dilemma.

The critical point to note is that if players do not communicate and are only playing a single round of the game then defecting is always the best option - you minimise your losses and potentially maximise your gains. However, if the game goes on for an infinite number of rounds then strategies other than always defecting result in higher payoffs.

Given the resource constraints of many mid-tier buyers and the requirement to show that they are purchasing wisely, if I were an indirect supplier, I’d do whatever I could to ensure that I provided my mid-tier clients with whatever information they needed to prove they are buying well when they are buying my products and services.

This is not as straightforward as it sounds because the skill with which one has purchased a product or service can only be judged relative to the price others are willing to pay. However, if I were an incumbent indirect supplier with significant market share, I would use my own customer base to provide the evidence my customers need to justify their decision to re-contract with me for another term and I’d willingly give up my ability to differentially set margins across my similar-margined mid-tier clients in the hope it would derail some of the tenders I’d otherwise be forced to participate in (assuming of course that the bulk of my profit did not arise from differentially pricing similar clients).

To do this, I’d meet with all of my mid-tier clients and, with their permission, talk about my pricing. I’d explain that I very much want to charge them all the same low price but particular idiosyncrasies in their buying patterns mean I can’t. I’d tell each of them what they can do to their own operations to allow me to service them at a lower cost. I’d summarise this in a document for each procurement manager and when she is asked to justify why she is re-contracting with me, I’d recommend that she say to her CFO, “We have been dealing with this supplier for 5 years and currently have no service issues. Our users report that they are happy with the service they are provided. I have met with the procurement managers of 5 of their other mid-tier clients and, given our idiosyncrasies, we are paying the same rates for their services as they are (and one of them took the supplier to market last year). Based on this, I recommend we focus our resources on a spend category we are less confident we are buying well.”

In the mid-tier indirect procurement space, we are often not making the best use of our scarce resources, and by that I mean that we are not maximising the addressable spend per dollar spent on procurement. There are two reasons for this:

1. We should be making better use of tendering platforms (which I won’t discuss as there are others in the blogging world who cover this with far more authority) and
2. we far too often take suppliers to tender when we could achieve a similar result with a few rounds of negotiation.

But to negotiate well, we need information. Companies like the The Buying Triangle are on the right track in providing this information to their corporate clients. I predict a bright future for organisations who provide services to boost the negotiating throughput and effectiveness of organisations.

For incumbent indirect suppliers to companies who are not using services such as the Buying Triangle, I believe there is scope for the suppliers to better service their clients by providing relevant, high veracity, purchasing information. Perhaps they can establish a Lone Purchasing Organisation.

I’ve recently put together a list of measurable procurement team activities and a suggested metric for each activity. It’s by no means revolutionary but you may find it useful in your organisation.

Listed below are the activities and metrics. Note that your team’s metrics will differ from those listed below based on the behaviour you are attempting to drive within your team, your organisation, and your supply base.

1. Spend analysis: Enriched addressable spend mapped to the organisational hierarchy (as a percentage of total addressable spend)
2. Sourcing: Savings, total and savings divided by the sum of procurement staff salaries.
3. Ordering: Spend through Procurement-controlled channels (e.g. e-catalogues) divided by the sum of P2P staff salaries
4. Deliveries: Metric: Average elapsed time from supplier dispatch to end user receipt
5. Invoicing and payment: Metric: Percentage of invoices paid on the date due (or before with negotiated discount)
6. Contract administration: Metric: Percentage of total addressable spend under contract
7. Supplier management: Metric: Spend covered by suppliers providing simple cost and SLA reporting back to the procurement department divided by the sum of supplier management staff salaries.

You’ll have noticed that some of the metrics are ratios between the objective and the cost of staff. I find this useful in focusing staff not on the limitations of our resourcing but on the efficiency of the resources we do have, and to constantly search for ways to make themselves more efficient.

 A recent study at Harvard Business School identifies 5 leadership behaviours that are correlated with increased motivation, creativity and performance of team members. There’s nothing ground-breaking or even surprising in the results, but it serves as a useful validation of the importance of day-to-day management activities.

“The team leader’s behavior is critical. I found that there are five leader behaviors that have a positive influence on people’s feelings, and the daily diary method allowed us to identify these behaviors at a very granular level. One of these is supporting people emotionally. The second is monitoring people’s work in a particularly positive way, and that has to do with giving them positive feedback on their work or giving them information that they need to do their work better. The third behavior is just plain recognizing people for good performance, particularly in public settings. The fourth is consulting with people on the team—that is, asking for their views, respecting their opinions, and acting on their needs and their wishes to the extent that it’s possible. And the fifth category was a grab bag of things. But the most important aspect here was collaborating—that the team leader rolled up his or her sleeves and actually spent time collaborating with somebody on the work.”

Last week, Michael Lamoureux asked Dave Stephens, Dave Bush, Jason Busch, Tim Minahan and I to post on the future of sourcing. I’ve found their responses fascinating and informative. I’m regularly astonished at the insights I get from this group of guys (Why no women?) and how narrowly my expertise is focused. But, going with my strengths, I am posting on the future of sourcing as it relates to structuring effective purchaser / vendor relationships.

A couple of months ago I posted on a little experiment I conducted on sourcing music based on stated requirements. In the study I analysed the appropriateness of songs found by Pandora compared to songs played by Yahoo Music given the same requirements i.e. songs liked by a Dandy Warhols fan. I concluded that Pandora found more suitable music than Yahoo.

In my opinion, improving techniques to find vendors is not the future of sourcing. Reflecting on the best examples of sourcing I’ve seen over the past few years, I realised that they all involve the purchaser and the vendor creating a more efficient relationship structure rather than a purchaser simply finding a new vendor.

An example of a more efficient relationship structure is the vendor and purchaser using a novel distribution strategy that creates operational efficiencies for the vendor and a competitive advantage for the purchaser; or the vendor and purchaser working together to impact demand rather than unit cost. The critical feature of the more efficient relationship structure is that it is created by the purchaser contributing internal knowledge about such things as its purchasing patterns, logistical challenges and payment requirements and the vendor contributing its market knowledge to produce an item or service that perfectly fits the purchaser’s needs and the vendor’s ability to service those needs.

The future of sourcing will involve good purchasers using better techniques to find good vendors but it will also involve good purchasers and vendors creating great new products and services. As Time Magazine says of Rogers and Hammerstein “Each had already made his mark — but as collaborators they created musical theater that enchanted audiences and redefined the art form”.

I wonder what technology will enable this type of collaborative innovation?

I had a discussion last week with another sourcing specialist about whether it was better to reduce tender submissions to a weighted result out of 10 or to a dollar figure. My preference is to work with my clients to assign a dollar figure to intangibles such as risk of moving from the incumbent to a new supplier and to display a single dollar figure for each respondent. Of course, assigning dollars to intangibles is more art than science and generally uses some largely unsubstantiated theory to arrive at the result.

I’m happy to see that someone has developed a similarly unsubstantiated mechanism to assign a value to blogs based on applying the link to dollar ratio from the AOL-Weblogs Inc deal. Congratulations to Dave Stephens and Dave Bush whose blogs are worth more than three times mine and to Michael Lamoureux whose blog, after a prolific couple of months, is valued the same as mine. And further congratulations to Jason Busch who’s streets ahead of the rest of us.

A typical spend reduction initiative starts by convincing your C-Level executives to mandate the consolidation of spend throughout your company. Through such consolidation, you ensure your suppliers can reduce their margins yet still make enough to service the payments on their salespeople’s Beemers.

If you cannot consolidate your spend, you must find other ways to convince suppliers to lower their prices and/or increase their services without reducing their margins to an unsustainable, sub-Beemer, level. One way of doing this is to reduce your supplier’s cost of sales. Doing this, along with reducing your cost of managing your vendors, allows you to punch far above your weight with your suppliers.

Let’s consider two companies, Big Company and Small Company, buying a non-customised widget. If the widget salesperson is willing to set their margin for Big Company so that a sale results in $1 million gross profit, they should, theoretically, be willing to reduce their margin to the same level for a sale to Small Company that nets them $100,000 in gross profit provided that sale takes 1/10 the sales effort to close and execute.

So what does this have to do with the long tail concept? Well, if there is such a thing as the long tail in procurement, the long tail calculation must include both sales cost as well as transaction costs.

Debbie Wilson, author of Cool Tools for Purchasing, declares 2006 to be the "Year of the Blog". For those of you not familiar with her site, Debbie, amongst other things, publishes periodic commentary on procurement issues. Her opinions are poignant and I read her stuff as soon as it hits my in-box. Jason Busch calls Debbie the first blogger in the [spend management] sector.

In her latest piece, she asks "What are [procurement] bloggers getting out of this?" It's a valid question. Earlier this year Jason wrote a piece on why he blogs. Reading this was instrumental in my decision to start blogging although my reasons for blogging are not nearly as lofty. Jason says that he blogs because he saw "a void in the analysis of the spend management sector" and because he could "make a buck" - both noble sources of inspiration.

Unlike the noble Jason, I blog for myself. I suffer from the unfortunate affliction of regularly mulling over procurement issues regardless of whether clients are paying me to do so. Despite this constant procurement hum, it is not until I've written down my thoughts that I can concisely discuss them. Writing publicly forces me to write well or at least better. My readers are like personal trainers who encourage me to get out of bed on a Saturday morning and organise my thoughts from the previous week.

So, to you, my readers, Thanks! And to you, Debbie, I hope that answers your question.